Investment Risk, Return, and Analysis Techniques

Posted on Feb 2, 2025 in Business Administration and Management (BAM)

Sources of Risk

  • Interest Rate Risk: Variation in returns due to market interest rate fluctuations, affecting debt securities.
  • Market Risk: Systematic risk caused by bull and bear market forces, impacting share prices.
  • Purchasing Power Risk: Variation in returns due to inflation.
  • Business Risk: Risks associated with a company’s operating environment, both internal and external.
  • Financial Risk: Variability of income to equity capital due to debt capital, related to a company’s capital structure.

Return

The primary goal of investment is to maximize returns through income, capital appreciation, or inflation hedging. Income includes interest on bonds or dividends on equity.

Rate of Return

The rate of return is calculated as: (Annual Income + (Ending Price – Beginning Price))

Fundamental Analysis

A systematic approach to estimating future dividends and share prices based on economic, industry, and company factors. It provides a framework for rational investment decisions.

Fundamental analysis involves three steps:

  1. Economic Analysis
  2. Industry Analysis
  3. Company Analysis

Economic Analysis

A company’s performance is linked to the economy. Key economic variables to monitor include:

  1. Growth rate of national income
  2. Inflation
  3. Interest rates
  4. Government revenue, expenditure, and deficits
  5. Infrastructure

Industry Analysis

Companies belong to industries, and their performance is influenced by the industry’s fortunes. An industry is a group of firms producing similar products for the same buyers.

Industry Life Cycle

The industry life cycle includes pioneering, expansion, stagnation, and decay stages. Profitability depends on the stage of growth.

Industry Characteristics
  • Demand-supply gap
  • Competitive conditions
  • Permanence
  • Labor conditions
  • Supply of raw materials
  • Cost structure

Company Analysis

The final stage of fundamental analysis, where investors select specific companies after assessing the economy and industry.

Technical Analysis

Technical analysis focuses on share price movements driven by market demand and supply. It assumes prices move in trends or waves. It is the art and science of forecasting future prices based on past price movements.

There are two main methods for analyzing investment opportunities: fundamental and technical analysis.